Why the Lord Chancellor’s Announcement on the Discount Rate Should be Welcomed by Insurers as much a
LORD CHANCELLOR’S ANNOUNCEMENT: WHAT DOES IT MEAN?
On February 27, 2017, the Lord Chancellor, Elizabeth Truss, announced changes to the Ogden Discount Rate - a nominal interest deducted from lump-sum payments that represent the amount claimants are expected to earn by investing the sum awarded. It was announced that the rate will be changed from the 2001 set-rate of 2.5% to minus 0.75% for all personal injury compensation payments, beginning in March 20, 2017. Indeed, it is a significant announcement with rather clear implications: claimants with serious personal injury claims will now be awarded higher damages for their claims, while insurers - and some public bodies with personal injury liabilities like the NHS – will pay significantly more for personal injury claims.
INSURERS: HIGHER PROFITS
The impact of the latest 3.5% nominal decrease in the discount rate on the insurance industry becomes apparent upon a reference to a recent Direct Line analysis: a 1% decrease in the discount rate translates to £190 million in loss profits for the insurance industry. Such estimate, however, remain nominal figures and not real ones. The real figures are the ones that underpin the competitive insurance industry. They are likely to differ from nominal ones in practice. Practically, in the context of serious injury claims, these real figures are likely to show increased profits for insurers for four main reasons: Firstly, a reduction in the discount ratio will understandably increase the proportion of insurers’ net earned premiums, due to anticipated higher premiums after a lower discount rate. It is estimated by the Association of British Insurers that up to 36 million individual insurance policy could be affected by an increase in their insurance premiums; Secondly, serious injury claims constitute only a minor portion of personal injury claims. Insurers themselves report that only 1% of all personal injury cases in the tort system resulted in a payment of £100 000 or more in 2002 - and the case has not been much different today; Thirdly, those minor portion of serious injury claimants are likely to continue to settle for periodical payment orders rather than lump-sum payments, because it has been common for claimants with serious injury claims to take advantage of the inflation-linked periodical payment orders. This is even a more likely conclusion today after courts have been given discretion to make such orders in 2005; Fourthly, and lastly, most personal injury claims get settled out of court, with those settled in court often contested by insurers. The Pearson Commission reports that only 1% of cases are settled in court while 98% are settled out of court. Straightaway, those reports mean that 98% of claims that settle out of court are not likely to benefit from the new rate. They also mean that only a minor 1% of unusual cases (e.g. serious injury cases) goes on to trial that could potentially seek a higher reward with the new rate. However, those small portion of cases almost always get heavily scrutinized by insurers - unlike any other minor injury cases, so the cost of litigation is also unlikely to increase for insurers in this context. That being said, the exact impact of such a decrease in the discount rate remains unclear on the insurance industry, but what is clear is that insurers will increase their net earned premium reserves, when, in practice, only a very limited portion of those reserves will be paid out for serious injury claims.
CLAIMANTS: BETTER COMPENSATION
It is estimated that a 3.5% decrease in the discount rate will increase the overall value of personal injury claims to 57%, especially for young claimants. For example, in future financial loss claims, the value of a claim brought by a 45 year old man claiming lost of earnings of £37,000 up to 65 years old will be awarded close to £250,000 more damages under the new rate than the 2001 rate. This nominal difference is also closely matched for other heads of loss, like medical expenses. Evidently, linking the percentage of the discount rate in law to returns on the lowest risk investments means a less likelihood of under-compensation for those of utmost need for a full one.
MOTOR INSURANCE POLICYHOLDERS: COLLECTIVE RESPONSIBILITY AND EFFICIENT ALLOCATION OF FINANCIAL RESOURCES
The impact of such a decrease in the discount rate on motor insurance policyholders merits a long discussion. Briefly, it is regarded that the conundrum in tort law has not been a question of who ultimately pays for tort claims, but a question of how those claims will be paid out. That is, whether damages to injured claimants should be paid out by the tort system through the premiums of policyholders or by the social welfare system through the taxation process. None the less, it has almost always been the case that the public purse bears the burden of both the tort system and the social security system to some extent. In the context of personal injury claims, premium contributions, first, reflect collective responsibility toward the potential risk of personal injury caused by all motor insurance policyholders on the roads; and, secondly, encourage the efficient allocation of the incurred monetary increments on motor insurance premiums (i.e. whether through judges’ victim-tailored assessment of damages or by insurers’ heavy-scrutinization of serious injury cases).
A FORWARD-LOOKING VIEW: A MODERN APPROACH TO RATE-SETTING
Such a significant change to the discount rate after 16 years of political inertia in the context of personal injury claims should, generally, be welcomed by all stakeholders. However, it is germane to note that such a notable change to the rate can also be bemusedly abrupt, not least to the insurance industry in the short- run. It is imperative that the Government, at the very least, adjust the rate more frequently to reduce its impact on insurers and avoid under-compensation of claimants with life-changing injuries. It is regarded that there is at least one possible way to outflank the severity of any future changes to the rate: discount damages on the assumption of investments in short term bills, where the investment balance is adjusted to new market rates upon the maturity of those bills. For now, however, it is suggested that insurers do not get lost in the cull-de-sacs of legal battles and the political rhetoric of higher costs, at least until the next consultation paper on reforming the discount rate comes into fruition in Easter. Let us just hope that any further consultation paper does not get piled up on top of the previous unutilized consultation papers, leaving us with an anachronistic, inapt discount rate, again.